Tuesday, August 30, 2011

Short-term funds can give better returns than FDs

Most investors associate mutual funds with longterm investing, which is true for most cases. However, various fund schemes also provide lucrative short-term investment options. Some of these include liquid funds, ultra short-term funds and income funds, which invest in call money market and debt instruments, such as government securities, treasury bills, certificates of deposit, commercial papers and corporate debt papers.

"Currently, investments in short-term debt funds are lucrative as the interest rates on short-term government issues are higher than long-term rates," says Yadnesh Chavan, fund manager, fixed income, Mirae Asset Global Investments. According to Bloomberg, the spread between 10-year (8.2%) and one-year (8.17%) gilt papers shrunk to around .03% on 10 August against a 1.41% difference a year ago. This is due to the steady increase in prime lending rates by the RBI (11 times in the past 16 months) and the resulting tight liquidity as well as strained government finances.

BETTER THAN FDS:

If you want to invest for periods ranging from one month to two years, short-term mutual funds are a better investment choice than bank fixed deposits (FDs). "Usually, FDs don't offer a very high return for a short tenure. Top funds, on the other hand, can give returns of 8-9% a year for a short period of 1-6 months," says Ashwinder Singh, head, wealth management, Fullerton Securities & Wealth Advisors. The funds provide better returns as they can churn their portfolios and invest in different types of financial securities that have varying maturity periods.

Such funds are also more liquid as their exit load is usually nil or lower than the penalty imposed on premature withdrawal for FDs, which is 1-2%. Besides, short-term mutual funds are also more tax-efficient than FDs, at least till the Direct Taxes Code (DTC) comes into effect from 1 April 2012. While proceeds from FDs are added to one's salary and taxed according to the income tax slabs, in the growth option of debt funds, only short-term capital gains are taxed as per the tax slab. Long-term capital gains are taxed either at 10% (with indexation) or 20% (without indexation). "The dividend option yields even better returns," says Jayant Pai, vice-president, Parag Parikh Financial Advisory Services.

However, if you invest in a mutual fund now, it will probably mature after 1 April 2012. Under the DTC, there will be no distinction between long-term and short-term capital gains of non-equity mutual funds. The capital gain will be added to the income of the investor and taxed according to the applicable tax slabs.

HOW TO SELECT A FUND

While choosing a fund, the most important factor you must look for is the credit rating of the debt instruments in which these funds are parking their corpus. This is even more important in case of fund types that have a relatively long-term focus as these tend to invest in instruments which are more risky. Another fundamental to be considered is the expense ratio of the fund, which should be below the category average.

"The nominal returns from such funds are usually in single digits, so any saving on the expense front is welcome," says Pai. Financial advisers also recommend choosing a scheme where the assets under management are in line with or higher than the category average. "It will ensure that sudden redemptions don't have a huge impact on the cost of the scheme," says Pai.

Investors must also take into account the interest rate risks of the fund. The interest rate risk of a bond portfolio largely depends on the maturity profile of the fund. The longer the maturity, the higher is the rate risk. The overall interest rate environment is a good guidance to the way bond prices will move. "If interest rates are expected to go up, it's better to invest in funds with the shortest maturity tenure," says Chavan.

TYPES OF FUNDS

Here's a look at the different types of short-term funds that you can pick depending on your investment horizon and risk profile.

Liquid funds:

Investors with a time horizon of 3-6 months can consider liquid funds as these invest in debt instruments with a maximum maturity of 91 days. "The funds are also good to initiate systematic transfer plans as the exit loads are usually nil," says Pai. So, liquid funds can be used to deal with equity market volatility and augment one's returns.

These funds can provide you with better returns compared with those from savings account and also offer the benefit of averaging. They have low interest rate and credit risk as the funds invest in securities with shorter maturity periods that are highly rated.

Ultra short-term funds:

These invest in debt securities that mature within a year. "You may suffer a loss if you want to exit these funds within a month or so," says Pai. However, Singh believes that if an investor can tolerate volatility, these funds can turn out to be good options for parking surplus cash even for a day or up to three months.

Ultra short-term funds give higher returns and are more risky compared with liquid funds as they invest in instruments with longer maturity periods. They also have an advantage over liquid funds due to the differential dividend tax treatment. The dividend declared by an ultra short-term scheme is taxed at 12.87%, while that by a liquid fund is taxed at 25.75%. "In terms of tax benefit, it is definitely better for investors, whose incomes fall in the higher tax slabs, to invest in the dividend option," says Chavan.

Short-term funds:

These funds invest in debt securities with over one year maturity and their interest rate risk is low to moderate, depending on the maturity profile of the fund. Experts recommend these funds for an investment horizon of 18 months or up to two years. Exiting the fund at an early stage may lead to losses as these impose loads for longer periods. Such funds also choose debt instruments that have a maturity of less than a year, but financial advisers warn against such schemes. "If a fund is overweight in such short-term instruments, its average residual maturity falls below one year and the purpose of investing in a short-term fund is defeated," says Pai.

Income funds:

These are good for investors who want regular and steady income. "They help to diversify your portfolio and modulate the ups and downs of equity investments," says Singh. Income funds offer relatively high returns compared to the above three categories but are also prone to higher interest rate risk. "Invest in these funds if your horizon is beyond two years as it will help in moderating the volatility," says Pai. "These funds provide superior returns when the interest rate cycle reverses and the rates start coming down," says Chavan.

Gilt short-term funds:

These funds invest in different medium- and long-term government securities. "These are most suitable for people who want to invest in safe instruments that have zero default risk," says Singh. "Their net asset values (NAVs) rise sharply (double-digit returns are common) in a falling rate regime," says Pai. However, capital loss can occur in a rising rate regime as bond prices share an inverse relationship with interest rates and these funds usually have one of the highest residual maturities. "These funds deliver flat to negative NAV returns in a rising interest rate environment," says Chavan.

http://articles.economictimes.indiatimes.com/2011-08-29/news/29941456_1_debt-funds-mutual-funds-mirae-asset-global-investments/3

CRISIL launches Gold Index

CRISIL Research today announced the launch of the CRISIL Gold Index. The index will track the performance of gold prices in the domestic market. The objective of CRISIL Gold index is to provide an independent and relevant benchmark for performance evaluation of investment products with gold as underlying investment. This is the first index introduced by CRISIL in the commodities space and the ninth overall.

Since the global credit crisis of 2008, gold has been consistently outperforming the equity market and eliciting enhanced investor interest. Between August 2008 and July 2011, gold has given an annualized return of 22.91% compared to 9.3% by S&P CNX Nifty. According to Mukesh Agarwal, Senior Director - CRISIL Research, “Gold is considered to be one of the safest havens for investments. Typically, during uncertain times, gold acts as an effective hedge.” The strong performance by gold has also coincided with the introduction of Gold Exchange Traded Funds (Gold ETFs) and Gold Fund of Funds (Gold FoFs) in India. The objective of these funds is to provide returns that closely correspond to the returns delivered by gold as an asset class. While the first Gold ETF in the country was launched in March 2007, the product has gained momentum only over the past two years. The average assets under management (AUM) under this category have grown exponentially from Rs. 0.96 billion in March 2007 to Rs. 60 billion as on June 2011. Currently 11 asset management companies offer 11 Gold ETFs and three Gold FoFs in India. “When compared with holding physical gold, gold ETFs provide investors with various benefits like affordability, guaranteed purity, high liquidity, transparent pricing and low holding cost. These benefits along with the tax advantage make gold ETFs a more efficient way of owning gold,” added Mr. Agarwal. Globally, AUM of Gold ETFs has grown over USD 100 bn as on June 2011 as against USD 14 bn in April 2007.

Gold ETFs in India benchmark their performance to the price of gold on the domestic commodity exchanges or the local bullion market. However, use of different sources for performance comparison results in inconsistency and makes it difficult for investors to compare one ETF with the other. With the growing interest in Gold ETFs, it is important for investors to have a consistent benchmark index that can be used for performance comparison. According to Tarun Bhatia, Director - Capital Markets, “CRISIL Gold Index is an attempt to address this inconsistency and will serve as an independent and common benchmark for evaluating the performance of gold ETFs. The index construction methodology adopted by CRISIL is in line with the valuation guideline prescribed by Securities Exchange Board of India (SEBI) for Gold ETFs.” The CRISIL Gold index has a base date of 02 January, 2007 and is based on the landed price of 10 grams of gold in Mumbai.

Source: http://www.adityabirlamoney.com/news/503231/10/22,24/Mutual-Funds-Reports/CRISIL-launches-Gold-Index

Time to look at longterm bond funds

With equity markets and equity mJustify Fullutual fund (MF) schemes taking a breather from the global turmoil that impacted India in the past month, the action is slowly turning to the debt market. Long-term bond funds are gearing up for falling interest rates in India. Debt funds do well when interest rates fall as there is an inverse relationship between the two.

Long-term bond funds have increased their duration (ex- pressed in years; the duration tells you how much your debt fund would get affected if in- terest rates--your bond fund's yield--were to move up or down by 1%) and their average maturity or the number of years left for your debt fund's existing scrips to mature (see graph). Already, fund houses are offering potentially-attrac- tive fixed maturity plans (FMPs), while six-month short-term bond fund returns have shot up to about 7-8% per annum during the past six months.

We suggest you take a look at long-term bond funds, even if selectively. Here's why.
Falling interest rates Many fund managers believe that interest rates will soon start falling largely because in- flation is expected to stabilize.
At present, inflation is at 9.22% (as on 31 July). Though it has marginally dropped this year (9.47% at the start of 2011), in- flation is still up from where it was at the start of 2010 (8.68%).

One of the main reasons why fund managers claim inflation will fall is a potential drop in global oil prices. Market esti- mates suggest that almost 70% of India's oil requirements are met through imports. Rising oil prices globally have affected In- dia's imports; in simple words, petrol for our cars and other ve- hicles has become costlier by the day. Higher oil prices also lead to higher food prices be- cause it increases the cost of transportation of food items. To combat rising inflation, the Re- serve Bank of India (RBI) has increased the key interest rate (repo rate or the rate at which banks borrow from RBI) 10 times since April 2010.

But that is largely expected to change. “Crude oil prices globally are expected to cor- rect, especially since the crisis in Libya is expected to be re- solved sooner than later. Once Libya starts to manufacture oil, the supply of oil will increase that is supposed to bring down global oil prices,“ says Sandip Sabharwal, head of portfolio management services, Prabhu- das Lilladher Pvt. Ltd. Add a normal monsoon to that and Sabharwal feels that food infla- tion (food prices) should also come down slightly.

A slowing growth can also be another reason why interest rates could soon start falling.
The growth in credit offtake of companies from the banking system have been moving down over the past one year.
In simple words, companies have been borrowing less. As per data available from RBI, growth in credit (year-on-year) has dropped to 18.5% as on 29 July compared with 20.7% as on 17 June and 24% at the start of the year.

On the contrary, deposits have grown by 17.3% as on 29 July compared with 16.46% at the turn of the year. “A signifi- cant chunk of credit offtake could be because companies are borrowing for their work- ing capital (daily requirement) needs and not long-term ex- pansion or growth. There is a lot of concern about a lot of developed countries, especial- ly after the recent downgrade of the US and the continued turbulence in the euro zone, which could put downward pressure on commodity prices.
Growth is expected to slow down globally which could positively impact the domestic inflation trajectory,“ says Ra- jeev Radhakrishnan, head (debt funds), SBI Funds Man- agement Ltd. Radhakrishnan feels that although RBI may not cut interest rates in the “immediate future“, it may go for “an elongated pause“.

“If companies go slow in their activities and there is lit- tle demand for long-term money for growth and expan- sion, then the banks would in- vest their surplus money, which would otherwise be lent, in long-term bonds and gov- ernment securities, thus bring- ing down interest rates,“ says Ganti N. Murthy, head (fixed income), Peerless Funds Man- agement Co. Ltd.

In other words, falling inter- est rates will be beneficial to bond funds, especially long- term bond funds.
The concerns Apart from inflation that may take its time to come down, fund managers are watching India's fiscal deficit situation. Put it in simple terms, a fiscal deficit is the gap between the government's in- come and expenditure.

“Since the government in- curs a bill in food and fertilizer subsidies, we need to keep a watch on how much it spends and earns this year. Disinvest- ment has not happened to a large extent, so the govern- ment is not going to earn much here as was previously expec- ted,“ says Alok Singh, head (fixed income), BNP Paribas Asset Management (India) Ltd.
What Singh means is that if the government spends more than it earns through its usual means, it will issue govern- ment bonds to raise money.
The additional supply of gov- ernment securities in the mar- ket will bring down the bond prices and push the yields up.

Though inflation is expected to come down, there is no one answer on how soon it will drop. “The non-food manufac- turing inflation is above the comfort zone of RBI and hence we feel that the central bank may wait for this number to come down before pausing,“ says Vikrant Mehta, head (fixed income), AIG Global As- set Management Co. (India) Pvt. Ltd. Same is the case for oil prices, Mehta adds, and it will eventually come down.
Why long-term bond funds make sense?

Although it is anybody's guess when interest rates will actually begin to fall, it makes sense to take a partial expo- sure to long-term bond funds now. Debt funds managers have started advising investors to put money in them already.

With a large chunk of fund managers and bond market ex- perts expecting that interest rates may not go much higher than the present levels, long- term bond funds have started taking exposure to debt scrips with longer tenors.

Dynamic debt schemes that have the flexibility to invest in scrips across maturity periods depending on the fund manag- er's perception of where the in- terest rates can go have in- creased their average maturity periods. For instance, dynamic debt schemes schemes of fund houses, including Reliance Capital AMC, SBI Funds Man- agement and BNP Paribas AMC, have increased their average maturity periods to three to sev- en years, up from just about 10 months to a year of maturity, prevalent in May 2011.

Remember that though long-term bond funds have a duration up to three to even four years, that doesn't mean you should stay invested in them for long. Take strategic positions in them, instead. “In- vestors should avoid staying invested in them for a longer horizon. We are not expecting our economy to slow down very substantially. Bond yields will come down substantially or stay there for very long. In- vest for a time period of one year,“ says Sabharwal.

After the 10-year government security yield touched 8.463%, it has moved within a range.
Short-term funds and FMPs still look good On an average, short-term bond funds have returned 6.50% in the past six months and 5.39% in the past one year. These schemes too have increased their duration slightly--from 267 days on an average as of their April 2011-end portfolio to 350 days as per their July 2011-end portfolio. Says Mahen- dra Jajoo, chief investment offi- cer (fixed income), Pramerica Asset Managers Ltd: “Short-term interest rates are expected to re- main more stable than the long- term interest rates and hence they have made good returns in the past six months. They look good going ahead too.“ What to do If you wish to take a bit of risk for the chance of getting higher returns, go for long- term bond funds. Since these funds are marked to market and are open-ended, any fall in interest rates will benefit them (the prices of the underlying securities will rise; the inverse relationship of interest rates and scrip prices at play here).

Apply the same logic for short-term funds. Adds Rad- hakrishnan: “Short-term funds are marked to market but are subject to lower volatility be- cause their duration is limited (lower than those of long-term bond funds). But if you do not have a risk appetite and do not wish to risk your capital, go for FMPs.“

Watch out for exit loads: If you invest in an FMP, your money gets locked till the scheme matures. If you think you may need your money ear- lier, go for short-term bond funds. Apart from being open- ended, they also give more re- turns if interest rates start to fall. But most short-term bond funds impose an exit load for withdrawals before 180 days.

Long-term bond funds too, impose exit loads for early withdrawals before 90 days, going up to 365 days.

Source: http://epaper.livemint.com/ArticleImage.aspx?article=30_08_2011_020_001&mode=1

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